The insured was seeking coverage
under a claims-made policy for theft that occurred between 2002 to 2014.The embezzlement losses were approximately
$492,350.00.The insurer denied coverage
claiming that Colony, the insured, could not establish that the loss was caused by an
“Employee” under the Policy.

The money was stolen from Colony through its payroll and tax vendor, Employee-Services.Net (“ESN”).Through the contract between ESN and Colony,
ESN was allowed to withdraw funds from a designated bank account to pay
Colony’s payroll and taxes.Owners/Managers/Principals
of ESN, James Staz and William Staz (collectively “the Stazes”) pled guilty to
embezzling over $14 million from ESN’s many clients, including Colony.

Essentially, the Stazes would
withdraw money from Colony’s account, claiming that the money would be used to
pay payroll taxes.In reality, the taxes
would go unpaid, and the money would fund the Stazes’ extravagant lifestyle,
which included alcohol, strip clubs, jewelry, a luxury car, and a luxury home
“with a lavish three-tiered pool, a cascading waterfall, wet bar, and dining
area.”

The critical issue for the court was
whether the Stazes were “Employees” under the policy.In the policy, the definition of Employees
included “contractual independent contractor.”In the definition, “contractual independent contractor” had to be a
natural person.Thus, from the outset,
ESN, as a business entity, could not be a “contractual independent contractor.”Further, to qualify as a contractual
independent contractor, there had to be a written contract between Colony on
one hand, and on the other hand either (a) the natural person or (b) an entity
“acting on behalf of” the natural person.

The written contract was between
Colony and ESN.The Stazes were not a
part of the contract.Thus, to qualify
as “contractual independent contractors,” the court had to determine whether
ESN was an entity “acting on behalf of” the Stazes pursuant to part (b) of the
definition.

The court interpreted the phrase “acting
on behalf of” broadly due to its ambiguity.Thus, not only did the phrase mean to act within the scope of a formal
agency relationship, the Court also construed the phrase to mean actions in the
general interest of or in the general benefit of the natural person.Given this broad definition of “acting on
behalf of,” the Court determined that ESN acted on behalf of the Stazes when it
contracted with Colony.Thus, the Stazes
were Employees as defined by the policy.Because they were Employees, there was coverage for the loss and directed the insurer to pay the loss.The Court then directed the insured to
prepare additional briefings on potential costs, attorney’s fees, and interest
that it sought through its prayer for relief.

An important portion of the
analysis, in our opinion, was the Court’s use of the Federal indictment for the
Stazes.Using the facts of the
indictment, the Court concluded that ESN’s purpose was to facilitate the Stazes’
embezzlement scheme.No one, other than
the Stazes, benefited from ESN’s existence.Further, the Court emphasized that ESN was a tool used by the Stazes for
their criminal actions:“the Stazes “through
[ESN] defrauded ESN clients.” Id. at
*5 (emphasis in original).While not
explicitly done in this case, such findings could support a veil piercing
theory under North Carolina law, which would yield similar results through
equitable means.

Given the results of this case, it
would not be surprising to see a re-write of the “contractual independent
contractor” provision in the future.However, litigators could also distinguish this case on the basis of the
facts.The facts in the indictment
supported showing that the Stazes used ESN for their exclusive, personal benefit. One could potentially argue that similar facts, establishing this high-bar, close to a veil-piercing standard, would need to be found in order to meet the burden of “acting on behalf of” language. This would be distinguished from actions by a "lone wolf" employee at a vendor who steals funds without benefiting the owners.